Biden's business tax plan: More complexity, questionable effect

Gary Clyde Hufbauer (PIIE) and Euijin Jung (PIIE)

October 5, 2020 5:00 AM
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REUTERS/Mark Makela

US presidential candidate Joseph Biden, pressing his agenda to expand US employment, has released a plan to impose new business taxes designed to discourage offshoring of US manufacturing. The new proposal supplements Biden’s earlier call for Buy America that, as argued here, would impose high costs on US taxpayers. Biden’s business tax proposals are no less problematic. They could end up hurting US-based multinational corporations (MNCs) when competing against foreign companies to sell goods in US markets. However, the plan does have one good feature related to equitable taxation of “passthrough” entities.

At the very least, Biden’s proposals will make the tax system more complicated, making US consumers pay higher prices for the goods they buy and providing a gift to tax lawyers and accounting firms as MNCs seek to circumvent the proposals’ provisions. Moreover, other countries could follow US efforts to create more jobs on their soil, hampering international tax cooperation.

The storyline underlying Biden’s plan revives the “runaway plant” theme that inspired the 1972 Burke-Hartke tax bill. That bill, which never became law, sought to deny MNCs a credit against US tax obligations for income taxes paid to foreign countries. Making MNCs with overseas production a villain is misplaced. Research by Moran and Oldenski (2016) shows that US-based MNCs create more American jobs, invest more, export more, and conduct more research and development (R&D) than their homebody counterparts, through their participation in global supply chains.

Biden’s plan calls for an increase in the general US corporate income tax (to 28 percent) and a minimum tax (21 percent) on corporate income earned in all countries, including tax haven jurisdictions. Two key components examined here are offshoring tax penalties and new tax credits for bringing jobs home.

Offshoring tax penalties

The offshoring penalties in Biden’s plan reflect the tax doctrine known as “capital export neutrality” (CEN): namely, that a US-based MNC should pay the same tax rate on profits earned abroad (combining foreign and US taxes) as on profits earned at home. CEN tax doctrine was widespread 50 years ago, not only in the United States but also in other advanced countries. Since then, CEN has been abandoned by nearly all jurisdictions, including the United States in the 2017 Tax Cuts and Jobs Act (TCJA), because home countries did not want to burden their firms with domestic tax obligations when those companies ventured abroad. The core argument was that each country should be responsible for taxing firms on income clearly derived from production in that country.[1] Biden’s plan would, in some respects, go beyond CEN by taxing MNC foreign profits earned from sales to the United States at higher rates than their domestic profits.

Under Biden’s plan, the basic US corporate income tax rate would be lifted from the 21 percent TCJA rate to 28 percent. Before it was lowered in the 2017 tax law, the rate was 35 percent. Many Democrats agreed with Republicans that the 35 percent rate hampered the competitiveness of US firms. Still, Biden’s new 28 percent rate would be well above tax rates now prevailing in Ireland, the United Kingdom, Sweden, and other countries that have enacted lower rates to stimulate business and lure MNCs. Conceivably such countries would follow the US lead and raise their rates.[2] (Later in this blog we suggest an approach that would encourage them to do so.) But Biden would also add a 10 percent tax penalty—an additional 2.8 percentage points—to the basic 28 percent rate if a US-based MNC produced goods or services abroad and sold them back into the US market. There is no chance that foreign countries would impose this penalty on their corporations.

Biden’s plan does not directly state that a credit for foreign taxes would offset the new 28 percent rate, but probably so. Otherwise, US MNCs would be hit with severe double taxation: the foreign corporate income tax—for example, 30.6 percent to Japan—plus 28 percent to the United States. But less likely, given the 10 percent penalty’s purpose, is that the foreign tax credit would be allowed as an offset.

Foreign call centers especially irritate Biden for costing US jobs, even though they have no connection to manufacturing.[3] But the main problem with his plan is that it would disadvantage US-based MNCs in competition with foreign-based MNCs, since many of them will pay a lower tax rate than 28 percent, and none of them will have to pay the extra 10 percent penalty when they sell goods to the United States. For example, multinationals based in France, Germany, or Japan that produce competitive goods and services would be able to sell in the US market unburdened by the Biden taxes. If enacted, the Biden plan will effectively discriminate against US-based MNCs, which deliver spin-off benefits to the US economy, and instead favor foreign-based MNCs, which principally deliver spin-off benefits to their home countries. The spin-off benefit most conspicuously lost to the US economy would be R&D conducted in the United States to serve a global market. Over time, US-based MNCs would focus on producing abroad for foreign markets and, when the tax burden matters, leave segments of the US market to foreign-based MNCs that can escape Biden’s tax net. US consumers would pay higher prices owing to lessened competition in the US market.

In addition, the Biden plan would deny otherwise allowable deductions for US MNC production abroad if the overseas jobs could plausibly have been offered to American workers. For example, if a company cannot prove that an automobile transmission made in Mexico, or an electric car made in Canada, could not have been made in the United States, deductions for US R&D underlying the design of the transmission or car would be denied. Marshalling data to prove that production can plausibly be done only abroad will generate untold billable hours for tax lawyers and accountants and require more Internal Revenue Service (IRS) employees to check the calculations. This is a truly troubling feature of the plan.

Finally, the Biden plan would establish a minimum 21 percent tax on all MNC profits earned abroad, no matter where the goods and services are sold, and without any of the existing or new tax credits (except, in all likelihood, the foreign tax credit) sprinkled across the Internal Revenue Code.[4] Again, foreign-based MNCs would benefit from tax discrimination against their US-based competitors, when they produce in jurisdictions with tax rates below 21 percent.

The Biden business tax plan does have one worthy feature that deserves special notice. It would eliminate the 2017 TCJA’s 20 percent business income deduction for “passthrough” firms, namely Subchapter S corporations, sole proprietorships and partnerships that pay no corporate tax. These passthrough entities now account for more than half of US business revenues. The historic justification for no taxation at the business level was that all their income would be taxed in the returns of individual owners. To secure congressional votes, the 2017 TCJA departed from that justification and allowed individual investors a windfall deduction for 20 percent of otherwise taxable business income. As might be expected, a disproportionate share of the windfall has accrued to the top 5 percent of households. Biden proposes to repeal this gift to the rich, but he may run into objections from his own party, since passthrough firms enjoy bipartisan support by claiming the mantle of “small business.”

Tax credits for doing business in America

Biden’s plan proposes 10 percent “advanceable” credits (probably meaning refundable, whether or not the firm owes any tax, and probably available to foreign firms doing business in the United States) to encourage five enumerated modes of business behavior:

  • investing in a closed or closing facility;
  • retooling for advanced manufacturing;
  • incurring expenses for reshoring production;
  • expanding facilities to grow employment; and
  • enlarging the manufacturing wage bill.

While it might make sense to provide incentives for some of these activities, implementation will be tricky. Fitting a firm’s outlays into one of the favored categories will attract high-paid legal and accounting talent. Administratively, it might be easier just to provide an incremental credit for any firm that increases its payroll over a moving base. In any event, the 10 percent credits will cost tax revenue and perhaps reward business for something that would be done anyway. Moreover, there may be “double dipping”: for example, claiming a 10 percent investment credit for reopening a closed facility and another 10 percent incremental wage credit for enlarging that facility’s manufacturing wage bill. With taxpayer creativity, the new credits will offset a good portion of the revenue gain that might be anticipated from raising the basic corporate rate from 21 to 28 percent and from eliminating the 20 percent business income deduction for passthrough firms.

Another problem is that, if the Biden plan is enacted, with its obvious goal of luring foreign jobs back to American territory, other countries will emulate with their own tax and subsidy incentives. Over the past decade, the Organization for Economic Cooperation and Development (OECD), the association of leading industrial democracies, has tried to minimize the role of tax havens and establish minimum corporate tax rates. The predictable foreign reaction to the Biden plan bodes poorly for tax cooperation under OECD auspices and could amplify foreign efforts to tax the digital services of US technology giants. Other OECD countries will not be interested in embracing US notions of a minimum tax rate when the United States is simultaneously jiggering its tax law to move jobs onto American soil.

A simpler approach toward the same basic goals

While well intentioned, the total plan represents a big step backward from the aspiration of simple and uniform business taxation. Past research found that while investment demand is responsive to investment tax credits in the short run, the added demand mainly increases capital goods prices rather than the quantity of capital. Experience suggests that, if enacted, the Biden plan will not have a big impact and will fall far short of spurring an industrial renaissance in the United States.

If Biden is elected, he probably will not want to reconsider the broad contours of his business tax plan. But if he and his team are open to a simpler approach, with the same basic goals, they should consider the following elements:

  • A flat 25 percent rate on all corporate income, wherever derived, with tax credits only for foreign income taxes.
  • A “makeup” tax on US imports of goods and services, to the extent the exporting firm is based in a country with a lower than 25 percent corporate tax rate.

An approach along these lines should raise substantial revenue and prod foreign trading partners to raise their own corporate tax rates to at least 25 percent. Simplicity would reduce the call for tax lawyers and their tax avoidance schemes. Moreover, it could no longer be said that US and foreign MNCs make goods and services abroad in low corporate tax jurisdictions for sale to the US market.

Notes

1. In a world of global value chains and internet applications, bilateral tax treaties try to divide income between partner countries. In turn, MNCs try to source income in countries with favorable tax rates. And then, many countries, including the United States in the 2017 TCJA, try to circumscribe the MNCs’ shopping for tax haven by imposing home country taxes on “mobile income”, such as intellectual property royalties, no matter where that income is sourced. The latest twist is the attempt by France and a few other countries to impose a digital services tax on tech giants, on the argument that part of their income is sourced in sourced in the country where users reside.

2. Following President Ronald Reagan’s business tax cuts in 1986, many countries cut their rates. For competitive reasons, it seems less likely that they would voluntarily raise their rates in response to the Biden tax increases.

3. When foreign call centers are operated as branches of the home corporation, and not as separate corporate subsidiaries, their income is already taxed to the home corporation. It is not clear whether Biden’s proposed 10 percent tax penalty would apply to such branch income. If so, there would be administrative problems in accurately determining branch income—a figure that the home corporation would like to minimize. In any event, the Biden penalty would clearly apply to foreign corporate subsidiary call centers.

4. This proposal possibly came from Kimberly Clausing’s book, Open: The Progressive Case for Free Trade, Immigration, and Global Capital, 2019. Clausing is an advisor to the Biden campaign.

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Gary Clyde Hufbauer Senior Research Staff
Euijin Jung Senior Research Staff

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